Can a Direct Sales Company Require Reps Purchase Products For Commission Qualifications?

When I sense a gap in the industry’s understanding on an issue, I see it as an opportunity to learn more and write content that sets the record straight. I’ve been fielding a lot of questions lately on the subject of whether a company can require monthly product purchases as a condition for pay plan qualification. When I give the answer, I’m sometimes met with surprise. They’ll often say, “They’re doing it over here and over there…..are you telling me they’re a pyramid schemes!?” Here’s the truth: multilevel marketing companies cannot require their participants to buy inventory as a condition to participation. This is black letter law, meaning it’s a rule not subject to any dispute. Whether this principle comes as a surprise or makes no difference, an understanding of why it exists and where it comes from is crucial to the avoidance of regulatory trouble.

The best definition for what constitutes a pyramid scheme arises out of the 1975 FTC case, In re Koscot Interplanetary, Inc. What separates a legitimate MLM from an illegal scheme boils down to two basic elements:

(1) a participant’s payment of money in return for the right to sell a product/service; and

Richard Brooke Launches Direct Selling Company Legal Defense Fund

We have uncovered three great resources to help any entrepreneur, especially a network marketing independent professional! So much is spoken or written on how much you can make in direct sales, and very little mentioned about increasing your net worth! These resources will help you increase your net worth.

Also, the DS Edge Conference is right around the corner. It’s February 4th & 5th, 2016 in Newport Beach, California.

And last but not least, Richard Brooke, founder of Life Matters, and long-time ethics committee member of the DSA (Direct Selling Association) has launched a direct selling legal defense fund. The first recipient is Vemma Nutritional Company.

Here are a few points of interest Richard shared on the site, which I think are worth pondering.

Here are some mistakes that Vemma made which the FTC convinced a judge were worthy of an ex parte action
no due process, no notice, just seize and shut down the company.

Vemma had zero distributor enrollment fees, so most “customers” were also “affiliates” depending on the box they checked. The FTC and judge ruled them, as a result, NOT CUSTOMERS.
Vemma traded ethics and public reputation for immediate sales growth in a segment of the sales force edifying obnoxious behavior.
Vemma allowed distributor videos suggesting significant success by recruiting without appropriate disclaimers.

“And here are the results of the government’s actions.”

* Vemma was entirely shut down worldwide for almost a month while the receiver went about dismantling the company. The receiver repatriated international company bank accounts.

* By the time BK resumed partial control of the company, Wells Fargo had withdrawn his merchant account, placed his name and company name on a watch list (black list), making it impossible to obtain a domestic merchant account, and his sales leaders had cut deals to move to competitive companies.

* The court required Vemma to change its compensation plan to one whereby a sales leader could not be paid on their team sales unless Vemma could prove that 51% of that team’s sales came from customers with the title customer. Affiliate personal purchases cannot qualify them for bonuses, only personally sponsored customer and distributor purchases. That compensation plan is still not effectively programmed and functional as of me writing this almost four months after this event.

* Legal fees have already reached $1.4 million and are expected to reach $3+ million before the case is final.

* Vemma has to get court approval for any compensation, incentive, and/or marketing campaigns it wants to initiate.

FTC now appears to be taking – that any marketing plan that is binary and multi-level in nature is objectionable

Friday, October 16th, 2015, the Vemma legal team filed an emergency motion in the UNITED STATES DISTRICT COURT FOR THE DISTRICT OF ARIZONA, to move the Court for an order approving the revised compensation plan attached hereto as Exhibit “1” (the “Revised Compensation Plan”).

From the supporting documentation filed the FTC may have decided to change their argument from “just” the way Vemma markets their income opportunity, and using standard benchmarks like the Koscot test and BurnLounge opinion, to deciding that the “binary” compensation structure in and of itself is the real issue behind their complaint.

If this is not a misunderstanding on the side of the Vemma legal team, then it will be the first time since the Binary was crafted in the mid-90s, that any regulator has called the structure in and of itself into question.

What Does The Greatful Dead Have To Do With Network Marketing?

I went to a Grateful Dead concert in 1976. The band was at the height of cool at the time as they represented the counter-culture movement from the Haight-Ashbury district of San Francisco. Although I had been to a number of concerts before seeing the Dead, this concert was different because it was the first (and to this day the only) concert where I witnessed security personnel hauling stoned audience members out throughout the show like it was a revolving door, and I saw medical personnel take at least six overdosed people out on stretchers.

This was obviously a common occurrence at Dead concerts. I vividly recall that right after their first number (Truckin’), Jerry Garcia (lead singer for those of you not old enough to have a touch of grey) announced “Hey people, have a great time, but don’t do any stupid sh**!” Such profound wisdom in such a simple statement!

I don’t think Jerry Garcia’s admonition resonated with the audience that night (shocking, right?), but it should resonate loudly with direct sellers. I look back on the FTC’s last four pyramid actions, Vemma, Fortune Hi-Tech, Burnlounge and Trek Alliance, and in each case we can point to stupid things that that landed the defendants in the FTC’s cross-hairs. We can (and will) closely analyze compensation plans, compliance and marketing nuances that the FTC charges render MLMs pyramid schemes. But there’s a place for analysis, and a place for common sense. Let’s put common sense first, because it’s unquestionably the first and best defense against finding your business in the line of regulatory fire.

Let’s start with Equinox and Trek. In both cases distributors (with corporate knowledge) placed ads in the “Help Wanted” sections of newspapers. The ads led readers to believe that Equinox and Trek were seeking to fill employment positions. People applied for the “jobs” and showed up for “job interviews.” In egregious cases the job applicant would purchase an airplane ticket to fly to the city in which the “job interview” was scheduled. When people arrived for their job interviews, they were pitched on the MLM opportunity, sold a starter kit and a large amount of merchandise. This proved an effective recruiting technique, but it doesn’t take a rocket scientist to figure out that it was based on deception and would inevitably elicit complaints to regulators. You guessed it – STUPID MOVE!!!

Fortune Hi-Tech’s compensation plan had built-in stupidity. While FHTM sold some real products and services, FHTM also sold a $199 “training program” to new distributors and paid a multilevel override on the sale. The training program, to the surprise of … NOBODY, was simply a means of funding compensation for recruiting new distributors. Montana was the first state to investigate FHTM, and frankly, they missed this issue. However, enough money was flowing through FHTM that regulators could not help but notice that the growth was driven by recruiting rather than bona fide consumer sales. Once again, stupid reigned supreme and helped lead to the demise of FHTM.

The Burnlounge case was triggered by the incendiary combination of stupidity and arrogance. Burnlounge management and its top earning distributor conducted meetings rife with income claims. They told audience members they could earn $900,000+ in their first year (not even the top earner was making close to that much). A woman in the audience found the sales pitch interesting, so she brought her husband to the meeting the next night. After the meeting the woman’s husband pressed the presenters for information to support the pie-in-the-sky income claims. The presenters didn’t want to be bothered with him (nor did they have any support for their claims) so they told the man to mind his own business. It turned out he was the assistant attorney general for the State of South Carolina. The next day an investigation file was opened on Burnlounge. Ooops! Ring the stupid bell!!!

Most recently Vemma was shut down by the FTC. We don’t have to look very hard to see where dumb came into play. Several highly visible Vemma distributors built their businesses on college campuses. They would aggressively pitch the Vemma business to college students, telling themn that they didn’t need a college education or that they should use their tuition money to build a Vemma business. Could anyone have foreseen how that might lead irate parents to ignite a firestorm of complaints? Ummm … yeah …

Whenever an MLM is attacked by law enforcement, other MLMs want to scrutinize the defendant company’s policies and compensation plan and parse every phrase in court filings, orders and opinions and quickly make changes so that the same fate does not befall their company. But it’s a COLLOSSAL MISTAKE to assume that the critical flaws all reside in the compensation plan or policies. The first step should be to identify every element of STUPID (and arrogant) in your business and fix it. The company may have turned a blind eye to the stupid practice for years or thought because a practice is not specifically illegal, it’s okay. Most commonly, the stupid practice is effective at growing the business, so they try to rationalize that it’s acceptable. But guess what? Even if it’s not illegal, it’s still stupid! And it’s STUPID that most often brings MLMs into regulatory crosshairs.

So the first rule in avoiding legal problems; heed the advice of Jerry Garcia and don’t do stupid sh… stuff!

A Solution To The FTC & Critics Concern Of A Lack Of Ultimate Users In Network Marketing

Since at least 1979, regulators and critics alike have questioned direct retail sales to the ultimate user inside a direct selling aka MLM company. This last month we saw once again this concern raise it’s ugly head when the FTC went after Vemma as a pyramid, stating they didn’t have enough “ultimate users” to be justified a legit network marketing company.

The Temporary Restraining Order. The court found that there is a substantial likelihood that Vemma was running a pyramid scheme. However, the court also found that there were parts of Vemma’s business that were being operated legitimately. Therefore, the court amended the TRO and allowed Vemma to continue to operate those parts of its business that were being run legitimately, but enjoined Vemma from engaging in those practices that it viewed as illegal. As it relates to Vemma’s sales and compensation program, the court enjoined Vemma from incentivizing distributors to buy products to become eligible, or maintain eligibility, for compensation rather than for resale or personal use. (Emphasis added – this is HUGE!). This is seemingly contradicted by another statement in which the court prohibits Vemma from paying compensation related to the sale of products unless the majority of compensation is derived from sales to buyers who are not members of the Marketing Program. (Emphasis added).

Vemma remains enjoined from paying commissions on the sale of Affiliate Packs and on the sale of products to distributors if such sales accumulate sales volume that qualifies the purchasing distributor for compensation. This provision directly impacts Vemma’s autoship program; we will analyze this in much greater detail in upcoming analyses.

The Asset Freeze. Vemma’s assets and the personal assets of the defendants are unfrozen. The court found that the FTC did not present sufficient evidence that the assets were at risk of being dissipated.

The Receivership. The court found that because Vemma is prohibited from engaging in illegal practices, it was unnecessary to have the business run by the receiver. However, the court recognized that Vemma had engaged in numerous illegal actions, so it re-cast the receiver as a court appointed monitor to oversee the defendants’ management and operation of the business. This is a significant step as it puts Vemma’s management back in charge of the company. Of course, the problem is that the company is a mere shell of its former self since the receiver fired most of its employees.

The content of the court’s order simply begs for analysis, and we will be breaking it down into dozens of individual issues for you. However, it’s important to understand that while this is a considerably stronger outcome than other MLMs have experienced in the past following FTC action, the company has been devastated so the FTC still has its “win” (although it certainly has egg on its face for other reasons that we will discuss in subsequent posts). But as I pointed out in my last blog, we have much work to do.

In my opinion, today’s ruling is yet another scenario of another governmental entity acting under the color of the law overstepping its bounds. The FTC misled a federal judge to convince him to grant an order that effectively killed Vemma’s business. Then, before Vemma had a day in court, the FTC’s receiver overstepped the bounds of the Court’s order by firing the majority of Vemma’s employees. Vemma received no hearing until weeks after the FTC had done everything it could do to effectively kill the company.

In reading between the lines, today’s court order indicates that the court viewed the FTC’s action as overreaching. Notice that I said “overreaching,” and not that Vemma was innocent of the charges. That’s a key distinction because in so doing the court sent a message that the FTC went too far in convincing the court to issue the draconian relief set forth in its original order that froze Vemma’s assets, turned the company over to a receiver, and shut the business down.

Vemma was not an altar-boy, and the court’s order recognizes that. Indeed, the court’s order indicates that it believes that the FTC will successfully prove that Vemma was operating an illegal pyramid scheme. I’m not commenting on whether or not that is true, but nobody can credibly argue that Vemma and its distributors were not too aggressive in some practices. But did Vemma’s transgressions justify the FTC’s initial actions in killing the company? Or are we faced with a situation in which the FTC, as the top-cop in the consumer protection arena, is exhibiting and exercising a bias against direct sales?

I am not one to espouse conspiracy theories, but how many consumer (and OSHA, and EEOC, and on and on …) complaints have been filed against WalMart, McDonalds, or any other high-profile business? Does the government shut them down, freeze their assets, and appoint a receiver to liquidate the company? Does the government shut down an auto company when the company builds cars knowing that they have flaws because they calculate that the lawsuits from the ensuing accidents will cost less than fixing the problems? I have yet to hear of an asset freeze or ex parte shut-down of a tobacco company, although the harm they cause to individuals, our health care system, and society at large dwarfs any harms alleged to have been caused by Vemma.

Obviously these are extreme examples, but they are fitting. Let’s face it, the government does not kill businesses in other fields, even though their transgressions are far more devastating in terms of life and property than the harm that can be caused by a flawed direct selling company.

Let me be clear. I am not defending pyramid schemes. There is NO ROOM in the direct sales distribution channel for pyramid schemes. I am however shouting loudly about the bias that the FTC has for the direct selling industry. The court’s action in amending the Vemma TRO highlights that less draconian remedies are appropriate and suitable to address problems within our industry while legal proceedings wind their way through the courts. The Vemma case highlights this fact very clearly. The FTC identifies a target with an objective to shut the company down, conducts a flawed investigation, presents highly selective evidence to the court, and kills the company, all without due process of the law. What other industry gets such treatment? I can think of none.

So what do we do? One thing is for sure; we DON’T sit back crying boo-hoo, we’re such poor victims of the big, bad FTC. Direct selling is built on high-energy, high-output people who get things done! So these are my recommendations:

Make sure your house is in order. This is KEY! There’s no sense in trying to fix a system if each of us cannot fix ourselves. My guess is that every company knows, or at least has a good idea, of where it’s pushing the envelope. Find out if you’re overstepping the bounds, and let’s clean up our act.

Get in contact with your federal government officials. Contact your Senators and your Congress-person. You have a voice. Use it.

Work together. Sure, every company is in competition with one another. But on industry-wide issues such as the FTC’s abuse of power against direct sellers, a unified voice will have far greater effect than everyone working individually.

I anticipate that change will be slow, but let’s get the conversation started!

Vemma Court Decision Expected Today

We’re expecting the court’s decision today in the Vemma action on whether the Federal Trade Commission’s temporary restraining order will be lifted, modified, or remain in place in the form of an injunction. There are MANY lessons to be learned from the FTC’s action, and we will be addressing them one-by-one in the coming weeks, so stay tuned. (Note: The order from the hearing is here.)

But as we wait for the immediate outcome, one thing of which we can be certain is that if the court completely lifts the TRO (highly unlikely), Vemma as we know it is done. The FTC’s favorite receiver did such a hatchet-job on the company that he killed it long before Vemma saw the light of the court room. Employees were dismissed within days after the raid, and while Vemma certainly had a cadre of loyal distributors, many more have departed given the specter of the FTC’s action.

The FTC’s playbook in pyramid cases is to freeze the corporate and personal assets of the owners, get an ex parte TRO, and have a receiver liquidate the company. The receiver in the Vemma case, Robb Evans and Associates, is the FTC’s go-to receiver in numerous actions, including the Trek Alliance and Burnlounge cases. Interestingly, a motion has been filed in a pending lawsuit in Utah to sue Robb Evans and Associates alleging that Evans is the FTC’s lackey, doing the FTC’s bidding because the Commission stamps his meal ticket, and in doing the FTC’s bidding he overstepped the bounds of the court’s order in the case. A recent article in the Salt Lake Tribune reports on this motion at http://www.sltrib.com/home/2953787-155/utah-companies-want-to-sue-court-appointed.

While I am certainly in favor of stopping pyramid schemes dead in their tracks, the FTC’s brazen disregard for Constitutional due process is appalling, and the direct selling distribution channel is at the receiving end of the FTC’s spear. I regret to say that in my opinion the industry itself is partially to blame because we have not been sufficiently proactive at the federal level. Let’s face it, although the FTC is charged with prosecuting pyramid schemes, the Commission is incapable of providing a comprehensible definition of a pyramid scheme. Rather, the Commission’s position on what constitutes a pyramid is at best a fuzzy and ever-changing. The industry itself has not done a good enough job at: (a) shaping a federal law or regulatory rule that clearly establishes the parameters of what constitutes a legal multilevel marketing program as opposed to what constitutes an illegal pyramid scheme; and (b) educating the FTC on how the industry actually operates.

Unless the industry can resolve this issue with the government, we will continue to be forced to deal with the FTC’s playbook and the denial of Constitutional Due Process and watch as one company after the next is buried. In coming months we will be addressing these topics, so stay tuned. In the meantime, we will report back on the outcome and the import of the Vemma decision as soon as it is published.